Our proprietary Fidelity Leading Indicator (FLI) is edging up towards the ‘top-left’ quadrant, which suggests that a trough could be approaching as we near year-end. Indeed, that things are broadly no longer getting worse has translated into the first positive FLI ‘bet’ for risk assets since February. This could suggest a window for risk to perform in Q4. However, it is still in the ‘bottom-left’, implying that activity is still heading below-trend, and likely decelerating. Take your pick between qualified optimism and qualified pessimism.
Source: Fidelity International, October 2018
The FLI’s creeping march towards the top-left quadrant where growth is negative but improving is a positive sign but given it remains in the bottom-left, we must still be cautious. OECD industrial production - which the FLI is designed to lead - has contracted over the past three months. The year-on-year FLI signal, which we discuss less and less, but can still be a handy indicator for markets, just dipped negative for the first time since H1 2015. By far the most positive FLI sector, global trade, is quite possibly experiencing a temporary front-loading effect as global supply chains race to get ahead of the impact from tariffs.
It’s not necessarily a surprise that global activity could be stabilising - the shocks in the global system have not been enough to totally reverse the strong growth we saw as we entered 2018. Nonetheless, the three key headwinds - US-driven monetary conditions, China slowdown, and higher oil prices - are yet to dissipate.
A small move into risk assets
The FLI ‘cycle tracker’ remains in the ‘growth below-trend and decelerating’ area for a seventh month. This is not a good sign, and suggests poor ‘optics’ for many economic indicators for some time. That said, the cycle tracker did post another steady tick towards the top-left (growth accelerating), and this incremental improvement, with all sub-sectors having finally stopped deteriorating, is leading the FLI bet to suggest a small overweight to risk assets.
Two of the five sub-sectors comprising the FLI have escaped the bottom-left quadrant. Global trade has positively surprised by remaining in the top-right quadrant since June, however front-loading activity could be artificially boosting indicators in the near-term. Consumer/labour finally moved into the top-left, with growth marginally accelerating driven by US data, in particular by strong consumer confidence.
The other three sub-sectors remain stuck with below-trend, decelerating growth, although industrial orders have at last been improving driven by an improving Japanese inventory/sales ratio. German new foreign orders remain very weak, but even here there are tentative signs of stabilisation. The data helps confirm the ongoing stabilisation seen in business surveys where marginal improvement came from beaten-up European bellwether surveys. Commodity-related components remain the weakest. If they can join the nascent upswing in coming months, that would certainly be a bullish sign.
Headwinds still in place
Despite some incremental stabilisation in the FLI, the key headwinds to global growth are yet to reverse. Primarily, tightening global financial conditions led by US monetary policy appear set to continue. The recent increase in real treasury yields only exacerbates this and the pressure on emerging market economies is unlikely to abate any time soon. China continues to show signs of a material slowdown and tentative easing measures appear insufficient to arrest the decline. Oil prices, which continue to move higher on supply constraints, are a large headwind to activity. From here, it is crucial to monitor how effective Beijing’s recent easing measures are, and how far they escalate. Any signs of the Fed relenting - perhaps slowing its tightening as we enter next year - would be reassuring. Conversely, the impact of tariffs, European political events, and second-order effects from EM weakness provide commensurate downside risks.
While the FLI bet has turned positive it is still pointing to further downside in global activity. This is true for quarter-for-quarter readings, and even more so for year-on-year data - with the yoy FLI dipping below zero for the first time in over three years. It is still likely that we will see slowing global growth in the coming months, however, barring a major external shock, the improvement in FLI momentum strengthens the possibility of growth plateauing around the turn of 2019. In summary, despite the small positive FLI bet, the overall picture still suggests caution, but if momentum manages to continue on its current course a little longer, perhaps we could even see outright optimism in 2019.